Seeking Alpha
We cover over 5K calls/quarter
Profile| Send Message|
( followers)  

Affymetrix, Inc. (NASDAQ:AFFX)

Q3 2009 Earnings Call

October 21, 2009 5:00 PM ET

Executives

Doug Farrell – Vice President, Investor Relations

Kevin M. King - President, Chief Executive Officer, Director

John C. Batty - Chief Financial Officer, Executive Vice President

Analysts

Derik De Bruin - UBS

Zarak Khurshid - Caris & Company

Marshall Lewis (ph) - Morgan Stanley

Eric Oscolo (ph) - Thomas Weisel Partners

William R. Quirk - Piper Jaffray

Quintin J. Lai - Robert W. Baird

Doug Schenkel - Cowen and Company

Tycho W. Peterson - JP Morgan

Jon Groburg - Unidentified Company Name

Isaac Ro - Leerink Swann

Presentation

Operator

Good afternoon, my name is Kasey and I will be your conference operator today. At this time, I would like to welcome everyone to the Affymetrix Q3 2009 earning conference call. All lines have been placed on mute to prevent any background noise. After the speaker’s remarks there will a question and answer session. (Operator’s Instructions) Thank you, Mr. Farrell you may begin.

Doug Farrell

Great. Thank you, Kasey. Good afternoon everyone, welcome to the conference call. At the close of the market today we released our operating results for the third quarter of 2009. Joining me on the call today is our CEO, Kevin King who will provide a commercial and operational update. Then our CFO John Batty will provide a detailed review of our operating results for the third quarter and our outlook for the fourth quarter. As a reminder today’s call is being recorded and the audio from the call is being broadcast over the internet on our homepage at affymetrix.com. During this call we may make various remarks about the company’s future expectations, plans and prospects that constitute forward-looking statements for purposes of safe harbor provisions under the private securities litigation reformat of 1995. Such statements are subject to risks and uncertainties that could cause actual results to differ materially for Affymetrix from those projected. These risk factors are discussed in Affymetrix’s Form 10-K for the year ended December 31, 2008 and other SEC reports, including our quarterly reports on Form 10-Q for subsequent periods.

We encourage you to review these documents carefully as forward-looking statements are made as of today’s date and we make no obligation to update this information.

Let me turn the call over to Kevin King.

Kevin King

Thanks, Doug. Good afternoon everyone and thanks for joining us. Our third quarter revenue grew by 4% over the prior year to $78.2 million, consistent with our guidance. Product and service revenue grew 5.5% over Q3 2008. R&A consumables were up 12% over last year driven by continued adoption of our whole transcript products and solid growth in our QuantiGene Product Line. DNA consumables were down 14% driven by what we believe is a temporary slowdown in whole gene home association studies.

For the last several quarters we’ve been updating you on our three primary business strategies. Reengineering our technology platforms, entering new markets, and increasing our operating leverage. Last week we made two important announcements that underscore significant progress towards these goals.

The first was the introduction of our new Axiom Genotyping Solution and the second relates to the 100,000 patient Kaiser UCSF epidemiology study that will be run on the Axiom platform.

The Axiom Genotyping Solution is our next generation platform designed to harness the significant rise in genetic content that’s being generated by government and privately funded sequencing projects. This high throughput automated genotyping platform enables researchers to find novel and causative genetic variance associated with complex disease.

Axiom supports both whole genome and target gene association studies with the level of customization not currently available. We believe the Axiom platform will expand our market share in the whole gene marketplace, but will also enable us to enter the targeted genotyping market. This later market segment has been estimated to be around $250 million in size and growing at an annual rate of more than 20%.

The Axiom solution is configured to continually valid and incorporate the output of large scaled sequencing projects. Initial product offerings are designed from top public databases of human variation and cover historical HapMap data that will be supplemented by additional variances as they become available.

Axiom is a revolution in customer choice and providers customers with unmatched flexibility to pick and choice their own array contents. We developed the Axiom platform with the goal of removing the limitations of fixed panel approaches. Our approach is similar to the way the music and video industries approach the emergence of digital technologies that enabled contents to be separated from the medium. Preselected store bought tracks quickly gave way to powerful on-line digital databases that offer customers maximum flexibility.

In a similar way the Axiom platform enables scientists to create their own play lists in a form of customer rays that deliver maximum scientific value for their research. We’ll continue to screen the millions of punitive snips and insertions and deletions that are being discovered by the 1,000 Genomes Project and other sources. And we intend to make these available to customers using the Axiom Genotyping Solution.

The complete platform employs enzyme mitigated steps that confer sequence specificity in conjunction with affordable reproducible and highly automatic work flows. The Axiom asset has the flexibility to randomly access the geno and the accuracy of a highly specific logation based approach. This allows researchers to select markers that can maximize the statistical power of their study design.

The solution consists of Axiom array plates, a complete reagent kit, an automatic target preparation station developed jointly by Affymetrix and Beckman Coulter and the gene type multi-channel instrument.

The Axiom solutions performance has been thoroughly evaluated at leading genotyping centers in the US and Europe. It provides the highest level of performance. It is measured by key metrics including call rate, HapMap concordance and reproducibility.

Its view was 1 1/2 full time technicians can process more than 750 samples per week on a single platform with unmatched minimal level of user intervention.

The Axiom solution is being showcased this week at the American Society of Human Genetics in Hawaii where customer interest is strong. In addition, there’ll be more than 100 posters and presentations from investigators using Affymetrix products and nine posters from Affymetrix scientists focused on our latest technologies including the Axiom platform.

If you are not able to attend, we’ve posted a wealth of information that you can access by visiting www.axiom.affymetrix.com.

Last week we announced that Kaiser and UCSF has selected the Axiom solution for their 100,000 patient study of disease, health and aging. This $25 million NIH funded project is one of the largest genotyping studies ever conducted.

UCSF will be running the samples and will purchase multiple gene-type instruments to meet their through-put needs. We expect UCSF to begin running samples during the fourth quarter and to complete the project in the next two years.

Grant funds were allocated for Affymetrix instruments and consumables as well as UCSF labor and overhead.

Customer interest and adoption of our genotyping instrument is strong and we’re tracking for our full year target of 35 systems. The genotyping application menu now includes many of our highest volume consumable products, such as our three prime IVT family, our whole transcript products as well as our new Axiom products.

In summary, we’ll continue to execute well against our strategic plan and achieve our financial goals. Throughout the year we’ve entered new markets and introduced new important products, such as Axiom or cytogenetic research offering in automated instrumentation. The combined effect of these initiatives puts us on track from improved top-line growth and profitability in 2010 and beyond.

John, would you take us through the specifics of our operating results?

John Batty

Thanks, Kevin. And welcome everyone to our call. I’ll begin my comments with a detailed review of our financial results for the third quarter followed by an update on our balance sheet before closing with our financial outlook for the fourth quarter.

For the third quarter of 2009 the company reported total revenue of $78.2 million as compared to $75.2 million for the same period last year. Total revenues were negatively impacted by a foreign exchange by approximately $1.2 million as compared to the third quarter of 2008.

Net loss was $8.8 million or $0.13 per diluted share, versus a net loss of $31.8 million or $0.46 per diluted share in the third quarter of 2008.

Q3 2009 net loss includes a restructuring credit of approximately $300,000 as compared to the prior year quarter which included $14.6 million or $0.21 per diluted share of restructuring charges.

Turning to the detail, third quarter product revenue was $66.2 million as compared to $66 million for the third quarter of ’08. Consumable sales were $62 million, up approximately $2.2 million from the third quarter of last year.

DNA revenue was $20.6 million as compared to $24 million during the same period last year. And RNA revenue was $39.9 million versus $35.6 million in the prior year. The product mix was about 2/3 RNA and 1/3 DNA.

Additionally instrument sales were $4.2 million as compared to $6.2 million in the prior year. We shipped 21 systems and scanners in the quarter bringing accumulative system shift to about 1,900. Also included in shipment sales is the income from our reagent rental program that we’re using to accelerate the adoption of our new genotyping platform.

Service revenue was $9.9 million as compared to $6.1 million in the third quarter of 2008. The strong services revenue included contributions from the University of Oxford and several other NIH genotyping programs.

Royalties and other revenue was $2.1 million versus $3.1 million in the third quarter of 2008.

In the third quarter total gross margin was 54.1% representing an increase of 500 basis points over the prior year quarter which included $3.1 million at accelerated depreciation for Sacramento Assets. Overall gross margins were impacted negatively by about a point on $1 million of lower licensing and royalty revenue.

Product gross margins at 53.6% were better by almost 3 points than year and were positively impacted by lower spending associated with the completion of our manufacturing transition activities relative to the second quarter product margins declined 1.9 points largely due to the under absorption at the planned for lower factory loading levels.

As a reminder, we told you last quarter that we would lower Q3 production output to avoid building inventories.

Service revenue margins of 48.1% improved over the third quarter of 2008 on higher revenue and a more favorable mix of programs.

Turing to operating expenses, operating expenses for the third quarter were approximately $49.1 million, which included $300,000 in restructuring credits. This compares to $68.8 million for the same period last year which included restructuring expensive of approximately $14.6 million and in-process research and development expensive of $5.1 million.

Q3 ’09 operating expensive included $2.4 million of stock compensation expense, as compared to $2.3 million in Q3 of ’08. Third quarter 2009 R&D expenses were $18.8 million as compared to $20.7 million for the same period last year.

The current quarter includes the addition of Panomics brand product development offset by lower project spending.

SG&A expenses in the third quarter of 2009 were $30.6 million as compared to $28.4 million for the same period last year, included the impact for the Panomics acquisition and higher litigation expenses.

The company recorded net interest and other expense of approximately $1.6 million in Q3 2009 as compared to a net expense of $1.8 million in the prior year quarter. This included interest income of $910,000 as compared to $3.4 million in the third quarter of ’08. Principally driven by the lower interest rate environment.

Interest expense of $2.4 million as compared to $3.5 million in the third quarter of last year on lower outstanding debt. And a net loss of $137K for the combination of investment, FX and other income as compared to a net loss of $1.8 million in the third quarter of ’08.

In the third quarter we recognize income tax expense of approximately $400,000. Our income tax expense for the third quarter is principally driven by foreign income taxes, foreign withholding taxes, and domestic income taxes net of federal R&D credit.

The net loss was $8.8 million or $0.13 per diluted share, versus a net loss of $31.8 million or $0.46 per diluted share in the third quarter of 2008. For diluted shares for the third quarter of 2009 were 68.8 shares as compared to 68.6 million in the third quarter of last year.

To facilitate the analysis of the company’s core operating results, I’d like to summarize our non-core adjustments to our net loss for the quarter and their impact on pre tax earnings per share. In aggregate these adjustments amounted to $1.4 million or $0.02 per share and include, living gross margin about a half a million dollars or roughly $0.01 per share, covering the amortization of acquisition related intangibles. $1.2 million or $0.02 per share in operating expenses which includes $1 million or acquisition related intangible amortization, $220,000 for a contingent consideration associated with our true materials acquisitions. And finally $300,000 credit towards restructuring costs.

Let me take a moment to summarize our balance sheet. We ended the third quarter of 2009 with total cash and available for sales securities of approximately $342.1 million as compared to $353.2 million as of the end of the second quarter of 2009. This cash flow including the impact of the settlement of shareholder derivative suit and the payment of our semi-annual convertible note coupon.

Third quarter DSL was 65 days, as compared to 63 days in the prior quarter. In the third quarter CAPEX was about 2.6 million in depreciation. And amortization was approximately $9.3 million which includes the amortization of acquired intangible assets.

Our net inventory for the third quarter of 2009 was $50.6 million as compared to $51.8 million in the second quarter of ’09.

Now I’d like to move to guidance. The company expects total fourth quarter revenue to be in the range of between $82-$85 million. While we expect to place a number of additional gene type instruments in the fourth quarter, we believe that the growth in related consumables will lag those placements as our customers transition and ramp the steady volumes.

We expect to see additional stimulus grants funded in Q4, but we don’t expect that such grants will have a material impact on our revenue until the first half of next year.

We expect gross margin percent to improve sequentially by about 100 basis points as a result of the contribution of new products and approved manufacturing absorption.

The company expects total operating expenses to be around $52 million in the fourth quarter. Our overall tax rate for 2009 will depend both on the level and geographic mix of earnings, but will be impacted predominantly by foreign taxes due to the presence of the full valuation on allowance on US based tax assets.

We expect our fourth quarter tax expense accordingly to be in line with the third quarter at around $400,000.

In summary, the outlook for our new products in promising and we’re encouraged to see an improved funding environment for the portion of our business. We look forward to updating you on the adoption of these new products in our year end call in January. Now we’d like to open the call for questions. Kasey?

Question and Answer Session

Operator

(Operator's Instructions) And our first question will come from Derik De Bruin with UBS.

Derik De Bruin - UBS

Hi, good afternoon. Can you give us just a little bit more color on the Kaiser agreement, I guess? You said that UCSF is buying systems outright. Who validated the platforms, how much work went into it, and how profitable is that agreement going to be?

Kevin M. King

This is Kevin, I'll take that. UCSF did a study of their own using the Axiom platform prior to the agreements being penned if you will, so they ran samples on the Axiom platform. If your question was about who else validated a platform, there were about five other customer sites that validated the platform. The results of those trials, if you will, are on the Axiom.Affymetrix website. There's a poster that's being presented at the ASHG meeting if you'd like to refer to that, and it lists the five customer groups and the results, the size of their samples that were run, and all of the other metrics.

Related to — they are buying gene titan systems. The profitability of the deal, it's a good deal for us. It's a very large deal. And it's a good deal. We're not disclosing the profitability of it, but profitability is pretty decent for us.

Derik De Bruin - UBS

Well, I mean I guess if they're running 100,000 samples, I'm just trying to get a — I guess what does it cost on a per sample basis on the new platform for that type of analysis.

Kevin M. King

So, price varies with volume and the list price for an Axiom per sample I think is in the order of about $250 is the list price on a per sample and it varies there based upon the volume, and I may be off by a couple of dollars on the $250, but I think it's pretty close to that.

Derik De Bruin - UBS

Okay. And then one final question and then I'll get back in the queue. Could you talk a little bit more about the overall US market? You said your DNA business was down about 14% as a temporarily delay, could you just talk about what you're seeing in that market and how you think that's going to evolve? And I guess, could you estimate what do you think your share is of the overall US market?

Kevin M. King

So as far as the market itself being down, I think we spoke about this in the past and I know other companies as well, a lot of work that had been done in the 2006, '07, and even to some extent, '08, are studies that are looking at common variance associated with common diseases. A lot of effort now is focused on looking at rare or variance associated with complex disease, and that data has not been made available for people to actually build arrays on until now with the Axiom product and so forth.

So we're expecting that the market will begin to pick up again. We've got a decent funnel of activity already for Axiom. Witness here with the Kaiser UCSF deal. As far as market share, boy, there are really no good market share studies or anything that's out there. In the past we thought we'd have roughly 50% of the market. I think when 6.0 came out I think we thought our share was higher than that. We took share. I think our competitors took some share from us in the later part of 2008 and I'd probably estimate it's close to 50% right now.

Derik De Bruin - UBS

I mean, looking at the literature there's been about 400 GWA studies that have been run to date. Do you think that scientists are going to go back and rerun all those on the new content chip?

Kevin M. King

Well, I think some of them will do extended studies. They'll do what we sort of refer to internally here as top off studies. So scientists will go back and ask the same question, but using different content, rarer variance, and that plays very well into the open database platform that we've created here with Axiom. But I also think people are beginning to ask different questions. What Kaiser UCSF is asking is an epidemiological question associated with the age of patients. Most of their patients in the study are in their mid 60s and their asking health disease and age related questions.

So I think people are going to be asking just as many new types of questions in ethnic categories, in disease categories, and in health categories.

Derik De Bruin - UBS

Great, thanks. I'll get back in the queue.

Operator

Our next question will come from Zarak Khurshid with Caris & Company.

Zarak Khurshid - Caris & Company

Hi, guys. Thanks for taking my questions, good afternoon. Back to the slowdown in the DNA business. Can you remind us, I guess of, the magnitude or maybe just quantify the slowdown last quarter where it was down, I think, 21% year over year. And then you're saying now it's down about 14%. I guess, how do these quarters differ? And then if you could tell us maybe just the sequential performance in the DNA business, that would be helpful as well.

Kevin M. King

Yeah, Zarak, I think last quarter we had a tough comparison because if you remember, we introduced the SNP 6.0 product in the June timeframe in 2007. We had one of our strongest quarters in the June quarter of last year at around $27 million. Most of the quarters have run between $20 and $23 million. So despite the fact that we were down this quarter, it was pretty consistent with the other two quarters of this year. We've ranged between somewhere around $20.4 million in the March quarter to $22 million in the second quarter. So sequentially we're about the same, but relative to last year, down.

Zarak Khurshid - Caris & Company

Okay, great. Thank you. And then as we're talking about the new content from the thousand genome project, I’m curious, how would you describe your competitive advantage versus the other folks in porting the new content onto your peg arrays and other products?

Kevin M. King

Sure. So the Axiom product is all about being an open database platform and it allows for a level of customization that has not been available before. And so it is not a fixed panel or closed system. I like to think about, just like the iTunes music model where customers can pick and choose their own playlists and not necessarily constrain to buying an entire album when all they want to purchase is a subset of the information.

Now why is that important? We believe that the market is going to produce somewhere in the order of $20-$30 million variants across a wide range of ethnic and disease and health related groups, and people are not going to want to be put in a corner with respect to fixed content on fixed array. We think people are going to want to pick and choose their content as it relates to their studies.

And as a result of that, we think this database approach that we've taken is going to be very powerful. The database will be publicly available to scientists and to non-commercial people for their use and for their use with the Axiom custom array design process.

Zarak Khurshid - Caris & Company

Very good, and then a follow-up question if I may. Last quarter you talked about some strength in the pharmacogenetic and cytogenetics research segments. Can you just describe the trends there and the progress? Thank you.

Kevin M. King

Yeah. Those markets as we spoke the last time, the pharmacogenomics market is potentially the largest of the two markets. It has the slowest ramp to adoption. We're doing well within the industrial side with PhRMA. They're continuing to increase the size of their studies from a handful arrays to hundreds of arrays to thousands of arrays for experiments, as well as in the academic area, customers like Corial Institute (ph) is doing a 10,000 sample DMAT study, along with our 60 projects with the 10,000 sample study. And so that adoption is good. It's a little bit slower because of the validation requirements for that.

On the cytogenetics research side, this is a very large market. We estimate it to be about $2 billion in size and we're making very good progress here around the world with that product offering that we have.

Operator

Our next question will come from Marshall Lewis (ph) with Morgan Stanley.

Marshall Lewis - Morgan Stanley

Yeah. Hey guys, good afternoon. So, a few questions. First thing, John, just on gross margins, I think that you guys had told us about the absorption issue, but I'm just trying to understand, are there lingering effects of that into the fourth quarter, and then how does that square with the sort of high fifties kind of number that you guys had talked about for growth margins once some of this manufacturing transition had been completed?

John C. Batty

Yeah. It's a great question, Marshall. I think if you look at this quarter, as we said last quarter we overdrove the factory to make sure that it was prepared for the growth that we saw ahead. It was one of the cleanest quarters where the Singapore operation was sourcing all of our arrays and Sacramento was completely shut down.

So we knew that we were going to basically operate the factory below its ship rate and that would have a negative impact this quarter. I think the difference between the gross margin that we reported this quarter and kind of the high end of the range was really just revenue driven. We came in within our guidance at $78 million. We gave a range between 78 and 82. We probably would have seen an extra point of margin had we hit that high side of the range.

Now, with respect to the fourth quarter, I think our view is a function of the adoption rate of our new products, and I think that it does take time with these new products before they collect all the samples that are required for the studies, and they line up the high volume activities on these new high margin products. So we're kind of taking a view right now that that's going to take a little bit longer.

Marshall Lewis - Morgan Stanley

Okay, gotcha. So at this kind of a level, I think your guidance range for next quarter are 82 to 85, that's just consistent — and then you guided to 100 basis points of gross margin sequentially. It's just basically consistent with what you said would have happened this quarter had you been closer to that kind of revenue range?

John C. Batty

Yeah, pretty much.

Marshall Lewis - Morgan Stanley

Okay, great. That is helpful. And John, on the expense side should we kind of think about — you guys have talked about some expense control in terms of absolute dollars, so is this quarter a reasonable run rate to use going forward or will there be some launch expenses associated with Axiom that we're going to see next quarter and into 2010?

John C. Batty

We've factored some of that into our guidance for the fourth quarter. Our guidance is $52 million and that's made up of some of these launch expenses with a new platform. Some of that will continue. And then we have, because it is our fourth quarter we have higher incentive compensations associated with higher sales, sales commission, and the like.

Marshall Lewis - Morgan Stanley

Okay, great. And then last question is just bigger picture on kind of how you are thinking about Axiom strategically. And obviously your major competitor had an announcement this morning talking about going to very high densities, 2.5 and 5 million SNPs on their next generation of chips. So how should we think about how the kind of peg platform is going to approach that market and if the 700,000 SNPs or so is on that platform, is that the limit from a per peg kind of density point of view? So to have a competitive product at that density, should we be thinking about that you're going to have to sort of spread content over multiple pegs for that sort of a product and then how does that kind of impact sample throughput?

Kevin M. King

Sure. So I think there’s two big factors here in the future of the genome wide association studies. One of them has to do with the need for genetic power. And it's pretty well known that the studies that have been done on common variance, you can use as few as 400,000 markers for reasonable coverage and this is related to a half map and common variant approaches.

As we begin to look at rare variance, the real driver here is going to be genetic power which is really a function of cost and the number of samples. And so, the view that we have here is that customers are going to want to pick and choose the contents associated with the rare variant that they're interested in studying, and they're going to have to run many, many studies, and so cost per sample is a key factor. The Axiom product's been optimized for high throughput and low cost per sample.

Now, each peg contains about 700,000 markers. We're not limited to using only one peg per sample. In the limit, I guess you could use the entire plate if you wanted, for a single sample. We're also not limited by our ability to put more content on a single peg. We have significant room to grow here. So I think what we've picked right now is a terrific offering for us and that the market is going to be appealed by the content that we have both within the database, our ability to put flexible content onto a marker, and the size of content within each marker.

Operator

Our next question will come from Peter Lawson with Thomas Weisel Partners.

Eric Oscolo - Thomas Weisel Partners

This is actually Eric Oscolo (ph) filling in for Peter. First off, on the instrument revenue, how much of the instruments or what percentage of instruments are you placing with that reagent rental business model?

Kevin M. King

Well, all the new platforms, the GeneTitans, there's a fairly significant percentage of those which will be placed with a reagent rental. The associated rental income has been relatively small as those systems are installed and as they line up these large experiments that we would anticipate next year.

Eric Oscolo - Thomas Weisel Partners

Okay. So is that partially responsible for that down-take in the instrument revenue quarter over quarter?

Kevin M. King

I think historically had we sold those outright we probably would have seen something similar, yeah.

Eric Oscolo - Thomas Weisel Partners

Okay, great. And did you break out organic growth?

Kevin M. King

We did not.

Eric Oscolo - Thomas Weisel Partners

Could you?

Kevin M. King

As we've talked on several calls before, it becomes increasingly complex to do this. As you know, the USC business is now been weaved integrally into a source of supply for reagents for not only this new Axiom product, but also our cytogenetics products. So that has become an important driver for expanding margin. The underlying products are doing well. The Panomics acquisition, as we've talked in the past, was incremental to this quarter since we had acquired them later in the year last year. We've been talking about this business in the range of $4-$5 million per quarter and I wouldn't change those estimates.

Eric Oscolo - Thomas Weisel Partners

And on the Panomics side of the business, can you maybe talk about what segments you're really seeing growth in and what are really high performing?

Kevin M. King

Sure. The largest area of growth is in the RNAI high throughput screening application. So these are RNAI knockdown studies that the pharmaceutical industry is doing. It's also using the quanta gene view plex application is an area of high growth. (Inaudible) number is anew product offering that was introduced in the second quarter. We see a lot of growth. And then the Procarta of protein based assays is giving a lot of growth as well.

The only area that is probably not growing as fast or is growing slower than that is the single plex Quantigene line looking at single markets, but the plex level products are growing quite nicely.

Eric Oscolo - Thomas Weisel Partners

Okay, great. And then one more question on Panomics, are you running that business at breakeven now, or is there still some costing synergies that he to be extracted from that?

Kevin M. King

Again, we're not measuring this as a separate business. We're kind of folding this in as a Panomics branded product line. So you'll hear more and more about these products as Procarta and Quantigene and the mid-plex products. We’re sharing resources within the company so we don’t report it as a separate business unit.

Eric Oscolo - Thomas Weisel Partners

Fair enough. And my last question, on the services segment, how can we think about that going forward? You did about $10 million this quarter, down obviously from last quarter. Is that $9-$10 million range, is that a reasonable estimate or is there going to be considerable variability in that to the next coming quarters?

John C. Batty

So let me offer a quick response here and, Kevin, if you have some more color, please feel free to jump in here. As we talked about our service business, this is a lumpy business and its characterized by large projects and some of these projects will extend into multiple quarters. So I wouldn't expect the characteristics of that business to change going forward. We've benefited from the large WCC project in the past. We had a women's health initiative last quarter. We had an NIH program this quarter in Oxford University. So it's difficult to predict with a high level of precision the timing of these things, but in general I would say it's lumpy and it falls within this kind of range.

Eric Oscolo - Thomas Weisel Partners

Great. Thank you.

Operator

Our next question will come from William R. Quirk, Piper Jaffray.

William R. Quirk - Piper Jaffray

Thanks, good afternoon. First question for me is I guess kind of going back to the gross margin question which is we obviously slowed the plant down and you guys did mention that in the 2Q call. What type of revenue performance can the Singapore plant support? Do we have to see, I guess, meaningful growth in the underlying business in order to hit some for the longer-term margin projections, or can you help us just think a little bit about I guess what the magnitude of the under-absorbed capacity is.

Kevin M. King

Yeah. Our goal when we set out to consolidate the factory was to size it around 75%-80% and the reason for setting it at that level was our business is historically non linear so we need to make sure that we've got peak capacity to deal with that non linearity. In a normal quarter, if we can run this factory at that 75%-80% range, we'll achieve the gross margin targets that we've been talking about.

William R. Quirk - Piper Jaffray

Understood. And then second question for me on OpEx is looking at the R&D spend in particular, obviously we're down sequentially. How much of this, guys, was timing versus, I guess fundamentally or institutionally lower levels of spending?

Kevin M. King

Again, that's a hard question to answer because it's always the sum of a lot of moving parts. I think you know that during the course of 2009 we had a fairly substantial investment in this brand new platform that we just rolled out and it spanned the spectrum of instruments, assays, software, and biochemistry. In addition, we also completed this diversity scan so that we could validate a number of the SNPs and essentially get ahead of the competition with validated content on our new product.

So as we move ahead, the characteristic of our R&D will change somewhat, but we'll be more focused on putting new content on those pegs as our customers give us input on what kind of content they would like to see. So, lots of moving parts there — hard to answer your question specifically.

In the SG&A area, I would say that the biggest factor that's impacting us now is increases in our litigation spending associated with the lawsuits that we've talked about in the past.

William R. Quirk - Piper Jaffray

Understood. And then the comments around R&D spend related to additional markers certainly I guess in my segway here, we've talked a little bit about slowdown in GWA and kind of what it would take to reaccelerate that. Are you guys willing to throw any timelines out here? Is this largely a function of waiting for data to be presented around major meetings and obviously incorporating that into the offering? Any guidance you can give?

John C. Batty

Well, I think the GWA studies or the opportunity for them to begin to increase starts now with the launch of the Axiom product line. We have millions of validated markers in our database today and we have the ability for customers to buy both catalog as well as custom products. So it's a matter of us getting out there and talking to people about these products and generating the interest.

Naturally, this will continue to progress over time as we screen more and more of the thousands genome content and validate the markers that have been identified there and put them into the database as well. I think you're going to see it throughout 2010 when you'll start to see a lot of this coming online.

William R. Quirk - Piper Jaffray

Okay, very good. Last question for me is whether or not you can talk a little bit or give us a little color rather, on the growth trends and in the cytogenetics as well as the diagnostics business with your partners of any change here from recent growth rates — any color would be appreciated.

John C. Batty

On the partners side for diagnostics, increasingly our partners are coming to market. We've spoken about path work in the past with their FDA cleared product. Clearly their volumes are increasing. I don’t think it's our position to disclose what those volumes are, but they are increasing as are other files like IPSOGEN and Almac and others, so that is increasing at a good rate.

On the cytogenetic side, we've really been starting from zero, and as I've mentioned in prior calls, we've got dozens and dozens of customers that have begun using this product line and this really represents a recurring revenue stream for us. So I'm quite confident that this is going to continue to grow as we go forward.

William R. Quirk - Piper Jaffray

Very good, thank you.

Operator

Our next question will come from Quintin J. Lai with Robert W. Baird.

Quintin J. Lai - Robert W. Baird

Good afternoon. Could you give a little color on how your commercial your big PhRMA big biotech demand was in the quarter and what's kind of baked into your fourth quarter guidance?

John C. Batty

I guess relative to last year, we've seen a recovery in the combined sort of breakout of pharmaceutical and industrial so we lumped those together. And part of it has to do with the fact that our Panomics branded products are really — they're not biomarker discovery, but they're rather more on the drug development path. So that certainly helped strengthen our pharma and industrial business. And then as you know, the cytogenetics product line is also lumped into that segment as well. So we saw nice growth year over year in that segment.

Quintin J. Lai - Robert W. Baird

So then in the fourth quarter, John, are you expecting kind of ac continuation of that with another deceleration of the DNA side?

John C. Batty

Well to be frank with you, we're not really planning on any major budget flush this year because we don't think those budgets are there to be flushed at the large PhRMA, typically with a consolidation, but you never know.

Quintin J. Lai - Robert W. Baird

And then, Kevin, with respect to your online music analogy, I mean the customizing of content, is there a gross margin that has to be given up or is there a pricing premium for users to want to design their own chips, and what's the turnaround time between their design to your delivery?

Kevin M. King

Well, I don’t' think necessarily there’s' a gross margin to be given up. I think you're probably referring to what's the cost of masking an array. Over the sample volumes that we're talking about for a lot of these studies, that number becomes very, very small for us to be thinking about on a per sample basis. Turnaround time for masks and things like that now are on the order of less than a month for us from the time we actually know what it is a customer wants to the time we can turn it around. So those periods are reasonable for customized-like markets.

Quintin J. Lai - Robert W. Baird

And my final question and I'll go back into the queue, but now that your OpEx and some of the restructuring that you've done is behind you, can you hazard what kind of revenue run rate you could need to get to EBIT breakeven and maybe when you might be able to hit that?

Kevin M. King

Well, I guess we're taking it kind of one quarter at a time so where the only guidance we're providing is to the fourth quarter, we’re going to provide a more comprehensive update at the end of the year. We're going to stick to quarterly guidance, but we'll give you some insight to that question. It's probably in the north of $85 million per quarter kind of range just off the top of my head.

Operator

And our next question comes from Doug Schenkel with Cowen and Company.

Doug Schenkel - Cowen and Company

Hey, good afternoon. One thing we haven't talked a lot about is stimulus. Any contributions from stimulus reflected in your Q4 guidance, and at this point would you be willing to at least talk a little bit about how meaningful the contribution from stimulus could be next year?

Kevin M. King

Doug, we are beginning to see stimulus dollars get awarded and released. Obviously the Kaiser UCSF win is stimulus related. That said, I don't think we expect a material impact on the quarter coming here into the fourth quarter. It's likely to be in the first half of 2010. We've got a good read, if you will, on what's been awarded. There are a lot of public databases out there that list microarray technology, instrumentation — I believe the BioArray News had a short article this week saying that there was about $75-$80 million of grant funding identified.

And my view with that, I think this is largely going to follow along market share lines with the exception that the big studies like the Kaisers and others that are out there will be deeply competitive and may not fall along those lines.

Doug Schenkel - Cowen and Company

Okay. So to be real clear it's promising and a nice source of upside moving forward, but in terms of what you're incorporating into guidance for the fourth quarter, there's not much there, if any at all.

Kevin M. King

Yeah. We talked about this at the last call as well that we're very optimistic that the rising tide is going to lift everyone here, but it's really hard for us to know exactly when these things are coming so we're not planning a whole lot of upside into our numbers.

Doug Schenkel - Cowen and Company

Okay. And then another GWA question, I looked through your Q2 transcript fairly recently and I might be forgetting something, but I actually don't remember you guys saying that you saw a GWA slowdown on last quarter's call. Assuming this is correct, which I think it is, did the slowdown in GWA that you mentioned today become something that became more apparent during the third quarter, and to what extent are you guys confident that this weakness you guys talked about is market wide given that Illumina hasn't reported as of yet, rather than increase competitive dynamics working against you given that this has been a bit of a challenging area for you guys for at least a few quarters?

Kevin M. King

Well, we track the marketplace in terms of studies that are going on in our sales force database. So we know win-loss ratios. We know sizes of deals. We know who's won them. We know if they've gotten funded and delayed and so forth. So we've got pretty good line of sign to how big the market is and where the studies are.

If you look at that and you look at just press announcements, GWA studies that are large tend to get public announcements or press announcements related to them and there really weren't any in the quarter than the UCSF one that I know of. So I think the market overall is slower on that side. I don’t think this is a market share.

I could be proven wrong. As you said others haven't reported, but I would venture at this point that I think it's market related.

Doug Schenkel - Cowen and Company

Okay. And last question and I'll get back in the queue. John, I think you had previously talked about getting gross margin into the low to mid sixties over the next year. This quarter you talked about some of the dynamics that maybe had you come in a little bit low for the guidance you provided coming into the quarter, but I just want o make sure that whatever’s going on this quarter or next quarter, one way or the other you guys still feel confident that you're tracking towards those levels for next year.

John C. Batty

Yeah. I think the discussion that we've had in the past is driven by two components and one of those components is largely complete, which is getting the factory infrastructure sized around the current business environment.

The second part has to do with the migration and the rate of migration to new products. And many of the new products were designed with the expressed purpose of achieving higher gross margins. So as we think about next year, the rate of conversion to these new peg and play based products, the adoption of high margin products like our cytogenetics products will have a tremendous influence on that margin.

Doug Schenkel - Cowen and Company

Okay. Thanks for taking the questions, guys.

Operator

Our next question will come from Tycho W. Peterson with JP Morgan.

Tycho W. Peterson - JP Morgan

Hey, good afternoon. A number of my questions have been answered, but maybe just a couple on some of the other new products. Can you just give a little bit of color on timelines for GENATLAS, where you are in beta trials and maybe how you're thinking for next year about just broadening the market opportunity for the peg format? That would be helpful.

Kevin M. King

Sure. As we reported last quarter, we have been executing against the plan for beta trials. We've completed many of them and continue to increase the number of systems that are out at sites for clinical trials. All systems look good at this point. We're planning on a launch in early 2010 for that product and we're really addressing both current customers, install bases, core labs, et cetera, that want to use the peg strip formats for work flow as well as for other reasons and we're also targeting new users, and actually that's where a lot of our beta trials have been taking place with new users that are unfamiliar to array based technologies and making sure that the product is an out of the box, turn it on, quick time to get ramped, and quick time for study results. And as I said, we’re getting pretty favorable results all around that.

Tycho W. Peterson - JP Morgan

Actually, maybe take that a step further. Could you kind of maybe weave that back into the discussion on operating expenses? As we think about the go forward strategy and sales headcount and things, I mean, if you're targeting a broader class of new users, I guess how do we think about the sales footprint as well for next year then?

Kevin M. King

Well, we're not expecting to increase the size of our sales force headcount. We've been reallocating our headcount throughout all of 2009. I think you know that we acquired USB and we acquired Panomics. We have our own Affy teams on the academic as well as industrial side and we've been remixing those in order to address these new markets; cytogenetics, pharmacogenomics, et cetera, and I think we're going to be able to cover this quite nicely.

And then also internationally where we think the GENATLAS is going to be a terrific product in places like Asia and so forth, we go to market through distributors and I think that they have a lot of capacity for that product already.

Tycho W. Peterson - JP Morgan

Okay. On true materials, can you provide a little bit of color there as well and how you're thinking about the validation of illiquid arrays and how we should think about that rollout?

Kevin M. King

Yeah . That program is progressing very nicely from the research phase into development. We have very robust capabilities now for making assays, putting oligos on the arrays, and we're in the process now of identifying the staging of the assay types that we want to go after whether they are DNA or RNA based and what the market segments are. And that work is progressing pretty nicely for us. We haven't made any announcements as far as timing for this year or next year on that.

Tycho W. Peterson - JP Morgan

Okay. And then just one last one on GeneTitan. Can you give us a sense as to the 35 placements you've talked about how many of these are multisystem order and then I guess on the consumable revamp you're assuming a couple of quarters to hit all throughput on the systems? Is that fair?

Kevin M. King

As far as multiple orders, I know of one customer that has two GeneTitans right now. The rest of one GeneTitan installation so the one that has two obviously is doing a lot of volume. I think the ramp to high volume is probably on the order of a quarter or two as you described. There's an installation phase, a training phase, and then people are doing comparison studies looking at the performance of cartridges to pegs and co-converting their staffs and so forth and that seems to take a little bit of time. Actually more than I would have guessed, but it is what it is.

Tycho W. Peterson - JP Morgan

That's great. Thank you very much.

Operator

Your next question will come from Jon Groburg (ph) with (Inaudible)

Jon Groburg - Unidentified Company Name

Good afternoon, thanks for taking the call. So first question with respect to revenues, can you maybe just describe how the quarter progressed relative to your expectations and then maybe lead into that into the fourth quarter, the guidance you gave, what would cause you to be kind of at the low end versus the high end of the range that you provided for the fourth quarter?

Kevin M. King

Well, we gave a range of between 78 and 82 and if you look at our guidance and how well we've done over the last four quarters, I think for the last three quarters anyway we've been at the high end of our guidance and in fact in some cases we've been above the range of our guidance.

This quarter we were at the low end of our range of guidance and to be honest with you, I can't point to a single event. Its just that's the way it came out and we do the best we can to try to identify a range of where revenue's going to be and we always try to be within that range. I'm not sure what other sort of intelligence you're looking for, Jon.

Jon Groburg - Unidentified Company Name

I just wanted to know if there was a particular project that didn't come through as you thought in the quarter or — I think you gave 78 to 81, but to be in the middle of that range if a particular business slowed down more than you thought as a previous question on the DNA side or again, kind of what the puts or takes on in terms of being at the low versus at the high end. And again kind of for the fourth quarter as well, if the Kaiser thing picks up a little faster than you think, you could be at the high end. If it lags you're probably going to be at the low end.

Doug Farrell

Jon, this is Doug. I think part of it is we've been talking with customers for awhile and investors for that matter too about our next generation genotyping platform. So certainly there probably are some projects where people were on the sidelines waiting to get these new generation of chips knowing they'd have the flexibility and the economies that had improved. So while it's hard to quantify a combination of that and people waiting for potential stimulus grants, probably it did put a little bit of a slowdown on GWA a little more than we expected.

Jon Groburg - Unidentified Company Name

Okay. And then, Kevin, to your point on — I think it was on the previous question on the idea of this customizable array, but you are still are using the photolithographic manufacturing, using these mass, and so you described it as once — given the size of one of these projects that becomes a negligible cost. What is kind of that breakpoint? At what point does it become cost prohibitive to have someone say hey I'd like to customize these arrays, but I'm only going to do X number and it's no longer profitable for you guys to do that?

Kevin M. King

Jon, I don’t know if I know the exact number, but I would say by comparison we have at least 400-500 custom gene expression products that customers buy from us and those products' volume can range as few as 400-500 samples and so the mass cost for that is often amortized inside of there and those are profitable deals for us. So I'm not overlay hung up on this as a barrier for us to reach a certain volume level in any way, shape, or form. I think we'll do just fine with it.

Doug Farrell

Maybe I'd add one thing too that obviously we've had a custom business in gene expression for a very long time and those are amortized over much smaller volumes. And if you think about these large genetics studies, there's a certain statistical power and sample volume that you need. So we don't think the masks are going to be a significant portion of that cost at all.

Kevin M. King

And maybe to that point, we've made significant improvements in our ability to reuse portions of masks. We've got different techniques and so forth and we've had one — maybe the company started 10 years ago and even as few as the last few years the development people have come up with novel ways to lower the overall cost of making arrays.

Jon Groburg - Unidentified Company Name

Okay. And then I think in the last call you gave a percent of your revenues that came from validation and routine testing given that you were saying that you were trying to move a little bit more in that direction as well as concentrate on the research side. Did you give — did I miss that on the beginning of the call or did you give a number there?

Kevin M. King

We didn't give a number, but we could probably do that as a follow-up as we go out here.

Jon Groburg - Unidentified Company Name

Okay. And this is the last, Kevin, just for you, just a big picture question. If at $85 million a quarter you can't earn a profit, at what point do you think that maybe you need to fold into a larger organization or if at all? It seems to me like on an $85 million run rate a quarter you should be able to be solidly profitable, so I'm just trying to understand how you're thinking about that big picture.

Kevin M. King

Look, this past year to year and a half has been a big transition year for the company with a lot of moving parts a lot of manufacturing changes, acquisitions, integrations, and a lot of puts and takes, and I'm very confident that as the company stabilizes, and it has begun to stabilize here in terms of predictable revenue, products that are coming out on time — true cost out in terms of manufacturing and so forth we will be profitable on an ongoing basis and I think the numbers that John spoke about are attainable for us.

Jon Groburg - Unidentified Company Name

Okay. Thanks a lot.

Operator

Our last question will come from Isaac Ro with Leerink Swan.

Isaac Ro - Leerink Swan

Hey, thanks for taking the question. Just first off a couple of follow-ups on Kaiser. I just wanted to confirm that is that deal in fact exclusive to you guys on the chip side and then maybe is it possible to think about follow-up work beyond the current two-year window where and is there any funding in place that you’re aware of to maybe extend the work beyond two years?

Kevin M. King

The grant is exclusive to Affy so the 100,000 samples are Axiom samples. I would imagine — I can't speak for Kaiser, but I would imagine they would want to do follow-on studies, but I don't have information to let you know that there's a larger cohort that's sitting behind us or not.

Isaac Ro - Leerink Swann

Right, okay. And then if you think about maybe the cytogenetics opportunity, could you maybe remind us as you said in the past, how you break down that opportunity within maybe the drug industry versus clinical settings? And I'm just wondering how important you think the clinical market is as I saw maybe in the trade press I thin last week a little bit of chatter that the FDA is placing a lot more scrutiny on how those arrays get used and how the regulatory path will work going forward. So I'm just wondering what dialogue you have had, if any, in this regard, and the extent at which it matters for growth rates that you're looking for out of cytogenetics.

Kevin M. King

Sure. Just going from memory here on the $2 billion. About $1 billion of that is split between cancer related cytogenetics, probably on the order of $400-$500 million, $400-$500 million in post natal testing. Then there's a segment on prenatal testing, and then there's a drug development and kind of an other category in the remainder and that's sort of the rough category there.

Right now we are only a research use only application for cancer as well as for cytogenetics research. I think you've made a good comment here. In order for us to access the larger market, at some point we will become a regulated product. We haven't disclosed any plans about that, but I do think we've got a terrific head start here with an FDA approved instrument, FDA approved arrays already, so we're well on our way to doing that, but we haven't disclosed anything about specific plans for those types of products.

Isaac Ro - Leerink Swann

Okay, fair enough. And then just lastly on the gross margin progression, I know it's been asked a couple of different ways here so I don’t want to belabor it, but if I just thought about structurally without specifics on numbers, how that progresses, is it fair to say that at some point maybe in the first half you could see sort of critical mass and then you pull through consumables that really drives a nice sharp uptick or is it really going to be sort of a steady progression over maybe a 4-6 quarter period. I'm just trying to think about how to model the progression over the next year and a half.

Kevin M. King

Yeah. I think you're going to see a steady progression. And again, it's a function of loading the factory which is now operating at a economic utilization level. So we get pretty good fall through as we absorb fixed cost. And then the other component will be kind of the forced multiplier, if you will. On the same sequential growth of revenue, as the mix gets richer we should pick up additional points. So I think getting to those kinds of goals towards the end of the year are certainly what we're striving towards.

Isaac Ro - Leerink Swann

Great. Thanks very much.

Operator

And we have no further questions.

Doug Farrell

Great. Thank you, operator. Thanks, everybody for taking the time to join us on the call today. If you did miss any portion of the call, a phone replay will be available for the next seven days beginning around 5:00 PM Pacific Time today. If you want to access that reply, domestic callers should dial 800-642-1687. International callers please us 706-645-9291. The pass code for both is the same, 34032730. Alternatively there's an audio replay that will be available under the investor section of our website at affymetrix.com. So thanks again and have a great day.

Operator

Ladies and gentlemen, that does conclude today's conference call. Thank you for your participation. You may now disconnect.

Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.

THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.

If you have any additional questions about our online transcripts, please contact us at: transcripts@seekingalpha.com. Thank you!

Source: Affymetrix, Inc. Q3 Earnings Call Transcript
This Transcript
All Transcripts